Hovnanian Enterprises, Inc. — Q1 FY2023 10-Q
Reporting period: Three months ended January 31, 2023; comparisons are with the three months ended January 31, 2022 unless stated otherwise. The company builds homes across 14 states and also provides mortgage and title services. Amounts below are in U.S. dollars.
Financial performance
- Revenue: $515.4 million, down 8.8%. Homebuilding revenue was $503.2 million; financial services revenue was $12.2 million.
- Home sales: 938 homes delivered, down 20.1%; average selling price rose 13.4% to $532,671. Home sale revenue fell 9.4% to $499.6 million.
- Profit: Pretax income was $18.0 million, down from $35.4 million. Net income was $18.7 million versus $24.8 million; common-stockholder income was $16.0 million. Basic and diluted EPS were $2.37 and $2.26, respectively, versus $3.12 and $3.07.
- Margins: Homebuilding gross margin was $93.2 million, or 18.7% of home sales, compared with 19.9%. Excluding cost-of-sales interest and land charges, the company’s non-GAAP gross margin was 21.8%, versus 22.4%. Management attributed pressure chiefly to buyer incentives and concessions, partly offset by lower construction costs.
- Cash flow: Operating cash use was $31.2 million, compared with $115.7 million used a year earlier. Investing cash use was $23.3 million; financing cash use was $48.4 million. Cash, cash equivalents and restricted cash totaled $279.3 million at quarter-end, down $102.9 million during the quarter. The company spent $134.4 million on land and land development.
- Liquidity: Management reported total liquidity of $365.7 million, including $234.9 million of homebuilding cash and $125.0 million available under its revolving credit facility. It said these resources should meet working-capital needs for at least 12 months.
- Debt: Senior notes and credit facilities, net, were $1.145 billion, plus $133.9 million of nonrecourse community mortgages. The $125.0 million secured revolver had no borrowings outstanding. Senior debt includes high-coupon obligations, including notes bearing 10.0%–13.5%. The company said it complied with debt covenants at January 31, 2023.
- Balance sheet: Total assets were $2.435 billion, total liabilities $2.039 billion and total equity $395.8 million at January 31, 2023.
Changes versus prior year and operating trends
- Net contracts fell 49.2%; contracts per average active selling community declined to 6.5 from 13.1. Backlog decreased to 2,028 homes valued at $1.178 billion, from 3,624 homes valued at $1.886 billion.
- First-quarter gross cancellation rate was 30%, above 14% a year earlier but below 41% in Q4 FY2022. January’s gross cancellation rate was 27%, still above the company’s historical average.
- Regional results diverged: Northeast pretax income rose to $28.5 million and Southeast to $11.6 million; West pretax income fell to $9.9 million from $43.9 million, as West deliveries declined 40.2%.
- Other interest expense increased to $15.1 million from $13.4 million. Total selling, general and administrative expense rose to $73.4 million from $72.2 million, and increased as a share of revenue to 14.2% from 12.8%.
- Cash use in operations narrowed year over year, while the quarter included $22.2 million of net investment in unconsolidated joint ventures. The company contributed four communities to a new joint venture for $41.1 million of net cash.
Outlook, commentary and risks
- Management cited mortgage rates, inflation and economic uncertainty as weighing on demand. It reported that sales pace improved in successive months during Q1, but said spring-season demand and the degree of further market pressure were difficult to predict.
- The company planned workforce reductions and other overhead cuts in Q2 FY2023 after weaker sales in the second half of FY2022 and Q1 FY2023. It also expects pressure from wage inflation, advertising costs and less favorable mortgage-rate incentives offered to attract buyers.
- Management reported extended build times from supply-chain issues, while expecting some improvement as lower construction volumes make labor more available. It is renegotiating certain land-contract timing or pricing and pursuing vendor and trade-partner cost reductions.
- The company said it may be restricted from paying Series A preferred dividends by fiscal year-end if operating conditions weaken and debt-covenant thresholds are breached. Preferred dividends are noncumulative. Management is evaluating capital-structure actions, but says debt covenants and market access constrain financing flexibility.
- A New Jersey condominium construction-defect case asserts approximately $119.5 million in damages, potentially subject to treble damages; an immaterial partial settlement was reached, and trial was adjourned without a new date. Separately, NJDEP claims over $5.3 million of investigation and mitigation costs at Hickory Manor, among other relief; discovery is ongoing. The company intends to defend both matters.
- Other material risks identified include home-price affordability, interest rates and mortgage availability, cancellations, land and construction costs, subcontractor and supply availability, environmental and development regulation, litigation, leverage and covenant restrictions.
Unusual items and capital allocation
- Net income included a $6.2 million energy-efficient-home tax-credit benefit, contributing to a $0.7 million total income tax benefit; the prior-year quarter had $10.6 million of tax expense.
- The company repurchased 118,478 Class A shares for $4.8 million, at an average $40.51 per share; $33.0 million remained under its $50.0 million authorization at quarter-end. It also paid $2.7 million of Series A preferred dividends.
- Land-option and related write-offs were $0.5 million, compared with $0.1 million. The filing reported no community impairment indicators and no inventory impairments in either comparison period.
Most important facts for investors to verify
- Whether contract activity, cancellation rates and backlog stabilize, and whether reported improvement in monthly sales pace continues.
- Whether incentives, construction costs and regional sales mix allow homebuilding margins and earnings to hold up.
- How cash use, land investment, reported liquidity and debt-covenant headroom evolve; confirm the availability and terms of the revolving facility.
- Whether weaker conditions trigger restrictions on Series A preferred dividends or limit refinancing and other capital-structure actions.
- Developments in the Great Notch and Hickory Manor litigation, including potential exposure and any changes to reserves.